A Financial Lifesaver Thrown by Creditors Weighs Cyprus Down

In Cyprus, fears of a bank run led to currency restrictions and a harsh bailout that have sent shock waves through the economy.Credit
Angelos Tzortzinis for The New York Times

NICOSIA, Cyprus — Soon after Cyprus was thrown what was supposed to be an economic lifeline in March, Polis Pilakoutas, a 25-year-old Cypriot plumber, had his workweek cut to three days from five. His salary shrank by the same margin.

“My boss was very straight,” Mr. Pilakoutas said. “He explained that he was having a cash problem.”

By April, the problem had become a crisis as the Cypriot economy went into a nose dive. The plumbing company failed. Mr. Pilakoutas lost his job along with all the other employees, as they became the latest casualties of harsh economic medicine that, across wide swathes of Europe, has often left the patient feeling only sicker.

Unemployment in Cyprus, according to figures released this month by Eurostat, the European Union’s statistical agency, was 16.3 percent in May, up 16.4 percent from before the March bailout deal between Cyprus and a group of three international lenders. It has gone up further since, economists say, though official numbers are not yet out. The rate for people under 25 is more than 30 percent.

Instead of fixing Cyprus’s problems, a tough rescue package for the Mediterranean nation has helped turn what began as a banking fiasco into a deep slump across an economy that, according to forecasts by the International Monetary Fund, will shrink by 9 percent this year and 4 percent next year.

That is bad enough, but, given the I.M.F.’s record of underestimating the pain to be suffered by earlier bailout recipients like Greece, the bleak forecast could prove too optimistic. In a June report, the fund acknowledged that Greece’s economic contraction between 2009 and 2012 — around 17 percent instead of the forecast 5.5 percent — “was much greater than anticipated.”

Sapienta Economics, a consulting group based in Nicosia, believes that Cyprus faces a cumulative economic decline of more than 24 percent this year and next. That would be the most precipitous slump in the European Union since the economies of the now 28-nation bloc began to shudder under the impact of a rolling debt crisis more than three years ago.

With an annual economic output of only around $23 billion, Cyprus is of little consequence to Europe’s overall economic condition. But it has outsize importance as a testing ground for Europe’s response to its seemingly unending crisis.

“This is a big experiment, and we are the guinea pigs,” said Alexandros Diogenous, the head of a company in Nicosia that imports German cars. “The guinea pig is in critical condition.”

Cyprus’s president, Nicos Anastasiades, said much the same thing in a letter sent last month to the so-called troika of creditors behind the bailout deal: the European Central Bank, the European Commission and the I.M.F. The Cypriot economy, he wrote, has been “driven into a deep recession” and will only get worse unless the group of lenders revises some of its terms. “I urge you to review the possibilities in order to determine a viable prospect for Cyprus and its people,” Mr. Anastasiades said.

In an interview, the president said that Cyprus intended to stick to its side of the bailout deal, which includes deep spending cuts, the overhaul of decrepit state companies and, most controversially, the effective confiscation of billions of euros deposited in Cypriot banks. But, he added, “I am not a magician.”

When Mr. Anastasiades took office in early March and decided to tackle the problems that his predecessor, a Communist, had largely ignored, he turned to the European Union for help, restarting stalled negotiations for emergency aid to shore up his country’s teetering banking sector.

After an all-night meeting in Brussels in mid-March, the troika agreed to provide around $13 billion on the condition that Cyprus “bail-in” the banks that had caused so many of the country’s troubles and force their creditors and depositors to take heavy losses. An initial proposal to confiscate money from insured deposits under $130,000 was quickly dropped, but the final plan, which shifted the burden to wealthy depositors and imposed tight restrictions on moving money, left much of the banking sector in a catatonic state. It also shattered public trust.

“We don’t trust banks, we don’t trust politicians, we don’t trust the legal system. We don’t trust anybody now,” said Christos Nicolaou, the director of a hotel and property company. “There is a big question over everything: What might happen next?”

Mr. Nicolaou said tourism, a pillar of the economy, was down by more than 10 percent compared with the same peak period last year but was still a relative bright spot. A wave of bankruptcies across Cyprus has so far been limited mostly to small companies and shops; bigger enterprises have stayed afloat by slashing wages and staff. But, Mr. Nicolaou said, “we are all on the list.”

Facing a particularly uncertain future is the financial services industry, a once-booming sector turbocharged by money from the former Soviet Union.

“I still cannot digest how criminal and crazy what has happened is,” said Irakli Bukhashvili, the head of a company in Limassol, the seafront business capital, that sets up companies and manages money for Russians and others. “An atom bomb wouldn’t be much worse,” he said, explaining that he plans to leave Cyprus and move his office to London.

Among those still faring reasonably well are lawyers, in part because those who lost money in banks have filed thousands of court cases to try to recover some of their cash. These efforts have not achieved much, but they have helped keep lawyers busy.

The nation’s finance minister, Harris Georgiades, acknowledged that Cyprus faces a “very difficult year or two ahead,” but he said the economic slump “could be less severe than many expect if we can plant the seeds for revived economic activity soon.” Cyprus, he said, is branching into new industries like solar power, and it benefits from having a highly educated and resilient population. It also has potentially large reserves of natural gas and, aiming to become a regional energy hub, last month began talks with one American and two Israeli energy companies on the development of a $6 billion liquefied natural gas terminal.

Mr. Georgiades noted that government revenue from the value-added tax, an important indicator of business activity, had picked up sharply after a catastrophic fall. It was down more than 60 percent in March compared with the same month last year but then rose by 23 percent in April.

Yet total government revenue is still falling, in large part because of a sharp decline in income tax payments, as bailout-mandated austerity measures slash wages and push people out of work. The government has drastically trimmed spending on wages and many other things but, because of rising unemployment and a rush of people into early retirement, its finances are in worse shape than before, as costs for pensions and social benefits soar.

Many businesspeople meanwhile worry that the worst is yet to come, complaining that fearful banks have stopped lending, cutting off circulation of the economy’s lifeblood.

Scores of Cyprus’s leading businesspeople gathered recently in a Nicosia conference hall to share doom-laden assessments of their prospects.

“The country is like a horse and cart. But the horse — the private sector — is now dead,” said Riakas Seraphim, a restaurant and shop owner from the coastal city of Larnaca. The meeting, organized by the Cyprus Chamber of Commerce and the Federation of Employers and Industrialists, ended with a joint appeal for the lifting of capital controls introduced in March and for banks to start lending again.

Before that can happen, however, the government and its international creditors must figure out what to do about the Bank of Cyprus, the country’s biggest and now gravely ill bank. Weighed down by an $11.75 billion debt to the European Central Bank that was transferred to its books from Laiki Bank, which is now defunct, the Bank of Cyprus is struggling to survive.

“It is now proven that the banking system is the A to Z. It is everything. If you don’t have a healthy system in place, you don’t have an economy,” said Mr. Nicolaou, the hotel and property developer.

A general sense of foreboding is aggravated by fears that once the summer tourism season winds down, the situation will get much worse, as visitors with cash drift away and Cypriot banks starved of money try to recover loans from borrowers who simply cannot pay.

“People haven’t yet realized what is going on,” said Panayiotis Athienitis, the head of a large building company that has suspended two big office projects since March because clients ran out of money.

“When people start losing their homes, they will revolt,” he said. “We are all on the hook right now. Everything is uncertain. It is a complete disaster.”

Mr. Pilakoutas, the fired plumber, has all but given up hope of returning to work any time soon after repeated, fruitless visits to a government-run job center. Former customers, he said, “now let their toilets leak longer before they call for help.”

A version of this article appears in print on July 14, 2013, on page A15 of the New York edition with the headline: A Financial Lifesaver Thrown by Creditors Weighs Cyprus Down. Order Reprints|Today's Paper|Subscribe